Definition
Longevity risk is the risk of outliving the financial resources set aside to fund consumption across one's remaining lifetime.
Why it matters
Longevity risk is the foundational economic problem that any lifetime income arrangement is built to address. Remaining lifetime is uncertain, and the right tail of the survival distribution is long enough that planning for an average lifespan leaves substantial exposure; the structural question for retirement income is who bears that exposure and on what terms.
How it works
For any individual, the date of death is unknown, and the survival distribution has a long right tail — a meaningful share of any retirement cohort will live well beyond the cohort's median lifespan. The risk decomposes into two components. Idiosyncratic longevity risk is the variation around the expected lifetime for an individual; this component can be reduced by pooling across many individuals because their lifetimes are largely independent of one another. Systematic longevity risk is the variation in expected lifetime for the cohort as a whole, driven by mortality improvement rates that are themselves uncertain, and it does not diminish with pool size.
In practice
An individual approaching the decumulation phase is, at the deepest level, choosing how to handle longevity risk. Three structural alternatives exist: bear the risk alone by managing assets through a chosen planning age, share the risk with a group of similarly situated individuals through a pool that redistributes assets from those who die earlier to those who live longer, or transfer the risk to an insurer that contractually pays for life in exchange for a premium that includes the cost of the insurer assuming the risk. Useful questions to ask a financial professional include: which of these structures does the recommended arrangement use, what survival age does the plan extend to, and what happens if the individual lives substantially past that age.
In the Longevity Standard Framework
Longevity risk is the foundational economic problem that the Longevity Standard framework characterizes solutions to. Risk sharing is one of four claim properties in the Longevity Standard framework, and its values — none, pooled, transferred, hybrid — organize how solutions to longevity risk are structured. The four properties — risk sharing, adjustment mechanism, liquidity, cost structure — together characterize any lifetime income arrangement structurally; risk sharing is the property that names whose problem longevity risk becomes once an arrangement is in place. The framework does not recommend a particular allocation of longevity risk; it provides the structural vocabulary that makes alternative allocations comparable on common axes.
Related terms
- Risk sharing
- Solo drawdown
- Mortality credits
- Idiosyncratic longevity risk
- Systematic longevity risk
- Lifetime income
- Frictionless pool